Contingent Pricing to Reduce Price Risks

T price for a product may be set too low, causing the seller to leave money on the table, or too high, driving away potential buyers. Contingent pricing can be useful in mitigating these problems. In contingent pricing arrangements, price is contingent on whether the seller succeeds in obtaining a higher price within a specified period. We show that if the probability of obtaining the high price is not too high, sellers profit from using contingent pricing while economic efficiency increases. The optimal contingent pricing structure depends on the buyer’s risk attitude—a deep discount is most profitable if buyers are risk prone. A consolation reward is most profitable if buyers are risk averse. To motivate buyers to participate in a contingent pricing arrangement, the seller must provide sufficient incentives. Consequently, buyers also benefit from contingent pricing. In addition, because the buyers with the highest willingness-to-pay get the product, contingent pricing increases the efficiency of resource allocation.